Commodities highlight May trends

Economic uncertainty still looms large

By

JimLowell

Editor of The ETF Trader

NEWTON, Mass. (MarketWatch) — There’s a lot of chatter about the market’s current state. Consensus seems to be hewing toward an overvalued view. Geopolitics and inflation are fog makers that obscure visibility at best and, at worst, add volatility to May’s passage. As if such fundamental concerns weren’t enough, the adherents of the adage of selling in May are cropping up on seasonal cue.

What’s an investor to do?

My view isn’t one of selling and sitting out what could be not only a trying month for the markets, but a trying quarter or two. There’s nothing in sight (earnings, economic data, domestic and geopolitics, commodity prices) to suggest an easy road ahead. Escalating inflation and/or a retreat in what had been a jobs market on the mend are also of concern.

There’s nothing in the known earnings reports and forecasts to suggest a dramatic pick up in the pace of recovery and growth. The best earnings growth gains may be behind rather than ahead of us.

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Still, overall, earnings weakness remains the exception to the rule even as the macro theme of slowing growth is emerging. After the torrid pace of trough-to-recovery leaps, the market is increasingly likely to be bound by less spectacular gains in earnings growth, leading to the potential for less spectacular gains. That’s hardly a new rumor, but it is new news.

Toward April’s end, we saw earnings growth under pressure expressed by distinctly different companies and industries, and for three different reasons. For Kimberley Clark it was the pressure of rising commodity prices to produce the goods it sells (Kleenex, Huggies, etc.). For the auto parts manufacturer and distributor Johnson Controls it was the negative impact of Japan’s post-quake production impairments. (Ford beat but expressed concern over coming quarter due to rising commodity costs and noted it will likely idle three plants on Japan-related parts shortages.) From NetFlix (which surpassed Comcast in terms of numbers of subscribers – now claiming more than 7% of all households), it was the age-old issue of having grown so well that future growth is likely to be markedly slower and lower. All three companies sold off on their future forecasts, despite delivering on past earnings.

With a market priced to perfection ahead of this round of earnings, and with earnings having beat that bar, a pullback is hardly unexpected — especially given the event-driven headlines and ongoing stagflation-like warning signs of rising inflation and a stalled jobs market.

Still, Intel beat with a 29% profit jump and delivered better revenue than forecast, which presents an upbeat outlook as “corporate refresh cycle is well under way.” IBM posted better-than-expected profit on better-than-expected revenue, and raised its full year profit forecast and outlook. Even one of my preferred blue-collar bellwethers, Polaris (snowmobiles/ATVs), nearly doubled its profits on an unexpected uptick in sales (the stock rose more than 15% on the day). Its chief executive noted that, “all product lines and geographic regions experienced increased sales”. EMC reflected similar lines of post recessionary refresh cycles found in Intel and IBM’s reports; business spending on IT and storage needs being driven by demand growth and the need to keep pace with IT upgrades.

Apple delivered an upbeat big beat on consensus, with an 83% gain in revenue, 95% surge in second-quarter earnings, 2.9 million Macbooks (53% increase compared to the first quarter) and 18.7 million iPhones (113% increase over prior quarter). At American Express, loan losses improved as did card member spending (must be all the business trips we’ve been on). GE (global bellwether) saw first-quarter profit soaring 77% from a year ago on strength in its transportation, health-care and aviation, and it announced a 7% increase in dividends. DuPont (you can’t have a recovery without chemicals) raised its outlook. McDonald’s: recession burgers continue to sell well (twice as much in Europe than here; reflective of a better recovery here than there).

With recovery under threat but still underway (in April, China raised its loan reserve requirements and Brazil raised its interest rates for the third time this year), earnings growth growing but slowing, technology demands upping the ante for recovery and while rising commodity prices could thwart all positives, I’ll make recommendations along the lines of all these trends being our friend.

Energy, timber and coal are all leaders in my seasonality charts of bygone Mays. Technology and telecom are consistent green shoots. Mid-cap growth and emerging markets have trended well in Mays past.

Here’s my recommended picks for this May’s basket.

The Claymore Global Timber
CUT, +0.68%
exchange-traded funds rolls up the paper and forest product theme related to recovery and rebuilding. Market Vectors Coal
KOL, +0.93%
would be my energy play of choice. It’s less expensive to mine, ship and use — making it increasingly more attractive as a fuel for the recovery. I also continue to like Powershares DB Agriculture
DBA, -0.65%
: cattle, corn, coffee, wheat, sugar, soybeans.

My broader market picks include: Vanguard Mid -Cap Growth
VOT, +0.19%
runs the consumer discretionary, technology and energy gamut well. For emerging markets, the sector picks above pan out as a basket of goods and services the emerging markets demand but can’t produce enough of. But I continue to like emerging market debt by means of Fidelity New Markets Income
FNMIX, +0.26%
and iShares Emerging Market Bond
EMB, +0.01%
as smart way to benefit from the demand for financing emerging market growth with less risk than an emerging market stock stake.

Such stakes aren’t riskless anytime. These days, I’d suggest that the risks could multiply to an overwhelming sum that delivers a setback of 10% or more in what could prove to be a not so merry month. But against the storms that are howling, I’m focused on the fact that they lend a landscape where blossoms can still be found.

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